CHICAGO - A controversial court ruling last month
that cast doubt on the use of life insurance trusts is already having a
chilling effect on the widely used estate planning strategy.

Worries over the decision effectively quashed a trust deal for John K. Bacci, a certified financial planner with Foundation
Financial Advisors Inc. in Linthicum,
Md. He was in midst of arranging
to have a client's $2 million life insurance policy placed inside a trust when
the lawyer involved demanded a letter from the insurer to "cover his
backside."

Big impact
feared

"The minute the attorney gets cold feet, it's done, it's over," Mr. Bacci said. "Attorneys are freaked from what I can
see."

In the case of Vera Chawla vs. Transamerica
Occidental Life Insurance Co., a federal court judge ruled that a
multimillion-dollar life insurance policy was void because a trust was the
owner and beneficiary of the policy.

Under Maryland
law, which was applied in the case, a trust does does
not have an "insurable interest" in the life of its grantor, because
it receives the death benefit, the judge said.

Potential impact 'enormous'

"The potential impact is enormous," said Mr. Bacci,
who has about a dozen clients with irrevocable life insurance trusts, or ILITs.

"If it's upheld under appeal, then we have reinvented estate
planning."

While the case has roiled advisers and estate-planning lawyers in Maryland, there are
concerns that states with similar laws could be subject to the ruling.

William Crispin, who represented the trustee, Ms. Chawla,
said the judge's holding, if sustained, could be adopted by courts in Alabama,
Arkansas, Illinois, Kentucky, Louisiana, Michigan, Missouri and possibly South
Carolina.

"For financial planners, just think of the situation they are in,"
said Mr. Crispin of Crispin & Associates PLLC in Washington.

If an adviser, particularly in Maryland,
recommended an ILIT and the life insurance claim is denied, "you will be sued, you have engaged in malpractice."

But the American Council of Life Insurers in Washington and the Association for
Advanced Life Underwriting in Falls, Church, Va., believe the judge's decision
was specific to the unique facts of the case and doesn't have broad
implications.

"We think it is unlikely that a position that an insurance trust lacks an
insurable interest will be upheld on appeal," said Tom Korb,
AALU director of government affairs.

Other lawyers and advisers share that belief.

As Michael Kitces, a financial planner in Maryland, puts it: "I don't view this by any means as the death
of irrevocable life insurance trusts."

"The classic line that most lawyers use is, bad facts make for bad
law," added Mr. Kitces, director of financial
planning at Pinnacle Advisory Group Inc. of Columbia, Md.
"This case is kind of a mess for lots of different reasons."

The Chawla case involves HaraldGiesinger, a single man in his 70s who tried to take
out a $1 million life-insurance policy with the beneficiary being Ms. Chawla, a friend in her 50s who was the wife of Mr. Giesinger's physician.

The insurance company, Los Angeles'
Transamerica, wouldn't issue the policy because Ms. Chawla
was not a relative and had no insurable interest in Mr. Giesinger.

Insurable interest is typically associated with family members or business
associates who stand to lose financially because of a person's death.

Mr. Crispin said Mr. Giesinger and Ms. Chawla had a "business relationship" and did some
real estate investments together.

"But there was a personal side to the relationship," Mr. Crispin
said. "He is a single guy and has no family and he became the godfather of
the Chawlas' children. He lived at the house a good
part of the time. They took care of him."

Mr. Giesinger took out a policy - later increased to
$2.45 million - in which the owner and beneficiary was a trust, meaning Mr. Giesinger and Ms. Chawlawere co-trustees.

But when he died in 2001, Transamerica denied the claim, saying that Mr. Giesinger had misrepresented his medical history on his
application, including failing to mention he had undergone surgery to remove a
brain tumor.

In the subsequent lawsuit, U.S. District Court Judge Claude M. Hilton in Alexandria, Va.,
ruled in favor of Transamerica. Applying Maryland
law, where Ms. Chawla lives, he agreed that there had
been medical misrepresentations.

But some say the judge took his ruling a step further than he had to, deciding
that life-insurance trusts in Maryland
cannot have an insurable interest regardless of who
the beneficiary is, according to Mr. Crispin.

"If a family in Maryland
has been paying their life insurance premiums for the last 20 years with the
notion that, if the husband died, the wife would be able to pay off the
mortgage with the insurance proceeds, maybe put the kids through school, guess what? Under this holding, as fought for by
Transamerica, there is no insurance for the wife if it is held in a
trust," he said.

Mr. Crispin is also baffled as to why Transamerica would raise the
insurable-interest issue.

"Is there a business reason, apart from winning this case,
that any insurance company would shoot itself in the head like this and
fight for a rule that would hurt its own business?"

Mr. Crispin asked. He is appealing before the 4th U.S. Circuit Court of
Appeals.

In a prepared statement, Bill Tate, Transamerica's senior vice president and
chief marketing officer, said the company does not view the ruling as
"having any application to trusts generally, including those set up for
estate planning purposes."

"We believe that because this particular decision was based on facts
unique to this case, it does not call into question the insurable interest in
policies owned by trusts," he said.

'Unintended consequence'

Still, William H. Van Pelt IV, president of the Mid-Continent Companies Ltd. in
Houston, a
national financial planning firm catering to the wealthy, also questions why
Transamerica would raise the issue.

"An unintended consequence is that sophisticated clients and their
advisers are going to ask the question: Do we have to worry about a carrier
just fighting the claim based upon a fact pattern that may be
complicated?"

Steven Oshins, a lawyer with Oshins
& Associates LLC in Las Vegas,
said it's not time to panic. That time would only come if other courts rule in
similar fashion.

"I have probably set up a thousand life insurance trusts and I can't have
the thousand people terminate their insurance and buy new insurance because of
one case that probably is wrong," he said.